EBIT vs. EBITDA vs. Net Income: How They Differ, and How New Accounting Rules Affect Them

In this tutorial, you’ll learn about the differences between EBIT, EBITDA, and Net Income in terms of calculations, expense deductions, meaning, and usefulness in valuation and company analysis. This tutorial reflects the new accounting rules for Operating Leases that went into effect in 2019.

Resources:

https://youtube-breakingintowallstreet-com.s3.amazonaws.com/106-19-EBIT-vs-EBITDA-vs-Net-Income-Slides.pdf

https://youtube-breakingintowallstreet-com.s3.amazonaws.com/106-19-EBIT-vs-EBITDA-vs-Net-Income.xlsx

https://youtube-breakingintowallstreet-com.s3.amazonaws.com/106-19-Best-Buy-Financial-Statements.pdf

https://youtube-breakingintowallstreet-com.s3.amazonaws.com/106-19-Target-Financial-Statements.pdf

Table of Contents:

0:00 Introduction

2:15 The Six Main Differences

3:43 Example Calculations for EBIT and EBITDA

7:21 Availability of Money

8:17 OpEx vs. CapEx

9:35 Rent or Operating Lease Expense

11:26 Interest, Taxes, and Non-Core Activities

12:05 Valuation Multiples

13:00 Usefulness of the Metrics

14:46 Operating Lease Details

16:39 The Annoying Interview Question

17:31 Recap and Summary

Lesson Outline:

At a high level, EBIT, EBITDA, and Net Income all measure a company’s “profitability,” but the definition of “profitability” varies a lot, and each metric is calculated differently and represents something different.

EBIT (Earnings Before Interest and Taxes) is a proxy for core, recurring business profitability, before the impact of capital structure and taxes.

EBITDA is a proxy for core, recurring business cash flow from operations, before the impact of capital structure and taxes.

And Net Income represents profit after taxes, the impact of capital structure (interest), AND non-core business activities.

How to Calculate EBIT vs. EBITDA vs. Net Income

EBIT (Earnings Before Interest and Taxes) is Operating Income on the Income Statement, adjusted for non-recurring charges.

EBITDA (Earnings Before Interest, Taxes, and Depreciation & Amortization) is EBIT, plus D&A, always taken from the Cash Flow Statement.

Net Income is just Net Income from Continuing Operations at the very bottom of the Income Statement (“Net Income to Common” or “Net Income to Parent” sometimes).

Availability of Money

EBIT and EBITDA are available to Equity Investors, Debt Investors, Preferred Stock Investors, and the Government.

This is because no one has been “paid” yet! These metrics are both BEFORE Interest Expense, Taxes, etc., since they start with Operating Income on the Income Statement.

Net Income (to Common) is only available to Equity Investors because the Debt Investors received their Interest, and the Government got its Taxes… but the Equity Investors have not yet received their Common Dividends.

OpEx and CapEx

EBIT deducts OpEx and the after-effects of CapEx (Depreciation), but it does not deduct CapEx directly.

EBITDA deducts OpEx, but no CapEx (both the initial amount and the Depreciation afterward are ignored).

Net Income is similar to EBIT: it deducts OpEx and Depreciation, but not CapEx directly.

Rent/Lease Expense

With EBIT under U.S. GAAP, there is a full deduction for Rent. Under IFRS, only the Depreciation element is deducted.

EBITDA under U.S. GAAP is the same: the full Rental Expense is deducted.

But under IFRS, nothing is deducted because both the Interest and Depreciation elements are added back or excluded when calculating EBITDA.

Net Income has a full deduction of the entire Rental Expense under both major accounting systems.

Interest, Taxes, and Non-Core Activities

EBIT completely ignores or “adds back” Interest, Taxes, and Non-Core Business Income. EBITDA is the same.

But Net Income is the opposite – it deducts Interest and Taxes, adds Non-Core Income, and subtracts Non-Core Expenses.

Valuation Multiples

Both EBIT and EBITDA pair with Enterprise Value to create the TEV / EBIT and TEV / EBITDA multiples, respectively.

Net Income pairs with Equity Value to create the P / E, or Price to Earnings, multiple.

What These Metrics Represent

EBIT is often closer to Free Cash Flow (FCF) for a company, defined as Cash Flow from Operations – CapEx, because both EBIT and FCF reflect CapEx in whole or in part (but watch out for Lease issues!).

EBITDA is often closer to Cash Flow from Operations (CFO) because both metrics completely exclude CapEx.

And Net Income is not great for comparisons or for approximating companies’ cash flows. It’s best as a quick and simple metric for quickly assessing a company’s profitability without doing extra work.

EBIT is best for companies highly dependent on CapEx; EBITDA is better for companies that are less so, or if you want to normalize/ignore CapEx and D&A.

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